China’s banking regulator is reportedly set to introduce a new department to oversee the nation’s $2 trillion trust industry in apparent recognition of growing potential risk.

Local media reported yesterday that the China Banking Regulatory Commission (CBRC) was seeking to add a spin-off entity from its non-banking division, possibly before the start of Chinese New Year next month.

The non-banking division, one of the 28 CBRC units, has hitherto been responsible for regulating trust companies, as well as firms engaged in corporate financing, finance leasing, automobile financing, currency brokerage and consumer financing.

Trust companies are ever-evolving entities that span private equity, asset and wealth management and banking. Their wide remit enables them to roll out a range of services in response to market change.

As a consequence China’s trust industry has grown exponentially ever since the CBRC introduced legislation governing trusts in 2001. It now stands at Rmb12.9 trillion ($2.1 trillion) in total assets.

That is almost three times the size of the nation’s Rmb4.6 trillion mutual fund industry, which has struggled for growth, as reported.

Trust products have become an alternative financing channel over the past 10 years for those companies unable to obtain sufficient capital from traditional banking sources. At the end of 2014, 10.4% of the trust industry’s underlying assets were in real estate, 21.8% in infrastructure projects, and 25.8% in industrial and commercial companies. Rating agencies had warned last year that the credit and liquidity risks associated with trust products could pose potential risks to major holders such as Chinese insurers.

In appreciation of the sheer scale of the trust industry, last month the CBRC established an insurance fund to act as a safety net in the event of a large-scale company restructure, bankruptcy, illegal activities or liquidity shortage.  

And now it appears the regulator is seeking to go one stage further, giving the trust industry its own regulating entity.

It comes after the default of an investment trust issued by China Credit Trust Company (CCTC) was narrowly avoided in January last year. The trust was backed by coal mine assets in Shanxi province which was short of liquidity, but CCTC found buyers for the coal mines and avoided a default. 

“The CBRC will have a greater workload in the future in terms of product innovation and risk management in the trust industry. Establishing a separate division allows the regulator to make more efforts in regulating the 68 trust companies, which will be positive for the industry’s development,” said Ivan Shi, analyst at Shanghai-based Z-Ben advisors. 

The trust industry saw slower growth last year. In the first nine months of last year, assets held by the trust industry grew 18.7% compared to the total at the end of 2013; however, in 2012 and 2013 the industry's asset base saw year-on-year growth rates of 55.3% and 46% respectively.

The slowdown was partly because CBRC has taken longer to approve new products. “Under CBRC’s administration approval system, innovative trust products like those which combine derivatives will be approved slowly, which dampens the industry’s growth,” Shi noted.

“The regulator’s important task is to manage the underlying risk of trust products, while the insurance fund aims to tackle any potential default events.”

A spokesperson for CBRC was unavailable for comment as AsianInvestor went to press.

A spokeswoman for the China Trustee Association declined to comment on the news when approached. She said it, too, was awaiting an announcement from the regulator on this development.

Mutual fund managers in China have long bemoaned their limited investment scope in traditional asset classes relative to trust firms, highlighting fund duplication and saturation as a consequence.

The need for product differentiation and diversification saw the China Securities Regulatory Commission (CSRC) introduce landmark liberalisation in September 2012, allowing fund houses to establish a subsidiary with an expanded investment opportunity set.

This includes unlisted instruments such as private equity, limited partnerships, creditor’s rights (such as entrusted loans), pledge of stock rights, investment trust products, accounts receivable and more.

This liberalisation was introduced to allow fund houses to compete on more of a level playing field for the first time. And fund houses have not been slow to take up the opportunity.

Already more than 70 of China’s 95 mutual fund houses now have a segregated account subsidiary, with more applications in the pipeline. Their collective AUM stood at Rmb2.3 trillion as of August 2014, a figure which had grown by 67% in six months. They were given permission to handle asset-backed securitisation business last November.

However, there are also question marks over the regulation of segregated account subsidiaries. Hong Kong’s Value Partners saw the subsidiary of its China joint venture become embroiled in a misappropriation probe, as reported.

A Value Partners spokesperson declined to comment, saying the firm was in a blackout period prior to announcing its 2014 annual results.